Part II in a my three part series on Behavioral Finance. By simply being aware of our own potentially flawed thinking and vulnerability to emotional biases, we can check ourselves in real time to see if we might be on the verge of a poor decision. However, I suggest you do some legwork to set yourself up for success.

Part II in a my three part series on Behavioral Finance. Let’s agree that humans are flawed and our thinking is flawed. Let’s further agree that we are rarely completely rational. Now that we’ve accepted our own human frailty, let’s discuss the nature of these frailties and how they can cause us to make poor decisions.

We’ve all done it — made a poor decision about money. Maybe it was because we didn’t know any better. Maybe it was because we got some bad advice. Or maybe it was because we fell prey to a cognitive error or emotional bias. The software that operates our brains is rather outdated, written thousands of years ago to help us survive in a very different type of world. Our brains have yet to catch up to the realities of our modern world. That prehistoric lizard brain we all have deep inside us can really muck up our thinking. Nearly every investor will have to face down their own lizard brain at some point during their financial lives.

All too often, clients come to me with investment ideas they like. Some are good and some are not so good, but many of them are complex. As humans, we are often seduced by complexity, as though the more glamorous or intricate an investment instrument is, the better it must be. Why own a set of simple and low cost index funds when you can buy a hedge fund? Why buy and hold when you can trade actively? Is the market falling? Why not short some stocks?! Just think of the possibilities!

When I sit down to talk with new clients and prospective clients who are considering the decision to hire me, I often ask them about their “risk tolerance” or “risk appetite.” “Do you know what your Risk Tolerance is?” I ask. More often than not, they shrug their shoulders and tell me they don’t even know what Risk Tolerance means. I’m never surprised at this, because there isn’t exactly a class in high school or college that would explain the concept — yet we are all expected to save and invest for our future. In the interest of helping you become a savvier investor, this month’s post is all about your ability to tolerate risk and why it matters.